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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 0-13406
THE CHALONE WINE GROUP, LTD.
(Exact Name of Registrant as Specified in Its Charter)
California 94-1696731
(State or Other Jurisdiction of
Incorporation or Organization) (I.R.S. Employer Identification No.)
621 Airpark Road
Napa, California 94558
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: 707-254-4200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----------------- -----------------
The number of shares outstanding of Registrant's Common Stock on November 7,
2001 was 10,301,479.
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THE CHALONE WINE GROUP, LTD.
PART I. - FINANCIAL INFORMATION
PAGE
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of September 30, 2001,
and March 31, 2001. 3
Consolidated Statements of Income for the three-month
and six-month periods ended September 30, 2001 and 2000. 4
Consolidated Statements of Cash Flows for the six-month
periods ended September 30, 2001 and 2000. 5
Notes to Consolidated Financial Statements. 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 8
PART II. - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 15
THE CHALONE WINE GROUP, LTD.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS
September 30, March 31,
2001 2001
---------------------------------------
(unaudited)
Current assets:
Cash and equivalents $ - $ 56
Accounts receivable, net 9,215 10,128
Inventory 59,738 59,333
Prepaid expenses and other 656 533
Deferred income taxes 1,360 897
--------- ---------
Total current assets 70,969 70,947
Investment in Chateau Duhart-Milon 8,494 7,824
Property, plant and equipment - net 72,383 67,197
Goodwill and trademarks - net of accumulated
amortization of $2,499 and $2,161, respectively 10,461 10,581
Other assets 1,252 1,342
--------- ---------
Total assets $ 163,559 $ 157,891
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 9,606 $ 7,517
Revolving bank loan 23,441 19,999
Current maturities of related party note payable 18 18
Current maturities of long-term borrowings 2,034 2,032
--------- ---------
Total current liabilities 35,099 29,566
Long-term borrowings, less current maturities 47,573 48,608
Related party note payable, net of current portion 892 882
Deferred income taxes 1,012 1,012
--------- ---------
Total liabilites 84,576 80,068
--------- ---------
Minority interest 2,973 2,689
Shareholders' equity:
Common stock - authorized 15,000,000 shares no par value;
issued and outstanding: 10,301,479 and 10,248,491 shares,
respectively 61,773 61,578
Retained earnings 18,841 17,901
Accumulated other comprehensive loss (4,604) (4,345)
--------- ---------
Total shareholders' equity 76,010 75,134
--------- ---------
Total liabilities and shareholders' equity $ 163,559 $ 157,891
========= =========
The accompanying notes are an integral part of the consolidated financial statements
3
THE CHALONE WINE GROUP, LTD.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited, in thousands, except per share data)
Three months ended Six months ended
September 30, September 30,
--------------------------- ---------------------------
2001 2000 2001 2000
-------- --------- -------- ---------
Gross revenues $ 13,396 $ 14,211 $ 27,299 $ 28,729
Excise taxes (344) (374) (719) (762)
-------- -------- -------- --------
Net revenues 13,052 13,837 26,580 27,967
Cost of wines sold (7,547) (9,522) (15,629) (18,240)
-------- -------- -------- --------
Gross profit 5,505 4,315 10,951 9,727
Other operating revenues, net (2) 27 29 38
Selling, general and administrative expenses (3,576) (4,094) (7,414) (7,762)
-------- -------- -------- --------
Operating income 1,927 248 3,566 2,003
Interest expense, net (1,032) (1,059) (2,059) (1,947)
Equity in net income of Chateau Duhart-Milon 183 215 382 533
Other income - 848 - 848
Minority interests (187) 154 (296) (102)
-------- -------- -------- --------
Income before income taxes 891 406 1,593 1,335
Income taxes (366) (166) (653) (547)
-------- -------- -------- --------
Net income $ 525 $ 240 $ 940 $ 788
======== ======== ======== ========
Earnings per share-basic & diluted $ 0.05 $ 0.02 $ 0.09 $ 0.08
Weighted average number of shares outstanding:
Basic 10,302 10,233 10,282 10,229
Diluted 10,381 10,233 10,355 10,229
The accompanying notes are an integral part of the consolidated financial statements
4
THE CHALONE WINE GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
Six months ended
September 30,
------------------
2001 2000
------- -------
Cash flows from operating activities:
Net income $ 940 $ 788
Adjustments to reconcile net income to net cash provided
by operating activites:
Depreciation and amortization 2,916 1,959
Equity in net income of Chateau Duhart-Milon (382) (533)
Increase (decrease) in minority interests 296 102
Loss (gain) on sale of assets (8) (837)
Changes in:
Deferred income taxes (463) -
Accounts receivable 913 (540)
Inventory (405) 3,361
Prepaid expenses and other assets (33) 511
Accounts payable and accrued liabilities 1,545 73
------- -------
Net cash provided by operating activities 5,319 4,884
------- -------
Cash flows from investing activities:
Capital expenditures (8,111) (7,541)
Property and business acquisitions - (3,518)
Proceeds from disposal of property and equipment 122 7,419
Distributions from Chateau Duhart-Milon - 564
------- -------
Net cash used in investing activities (7,989) (3,076)
------- -------
Cash flows from financing activities:
Borrowings (repayments) on revolving bank loan - net 3,442 (21,107)
Distributions to minority interests - (400)
Proceeds from private placement financing - 30,000
Repayment of long-term and other debt (1,023) (10,261)
Proceeds from issuance of common stock 195 -
------- -------
Net cash provided by (used in) financing activities 2,614 (1,768)
------- -------
Net increase (decrease) in cash and equivalents (56) 40
Cash and equivalents at beginning of period 56 -
------- -------
Cash and equivalents at end of period $ - $ 40
======= =======
Other cash flow information:
Interest paid $ 2,149 $ 1,867
Income taxes paid 83 139
The accompanying notes are an integral part of the consolidated financial statements.
5
THE CHALONE WINE GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - CONSOLIDATED FINANCIAL STATEMENTS
The unaudited consolidated financial statements of the Chalone Wine Group,
Ltd. ("the Company") are prepared in conformity with accounting principles
generally accepted in the United States of America for reporting interim
financial information, and the rules and regulations of the Securities and
Exchange Commission. In the opinion of management, all adjustments necessary for
a fair presentation of the financial position and results of operations for the
periods presented have been included. All such adjustments are of a normal
recurring nature. These unaudited consolidated financial statements should be
read in conjunction with the audited consolidated financial statements included
in the Company's Form 10-K for the year ended March 31, 2001.
The consolidated balance sheet at March 31, 2001, presented herein, has
been derived from the audited consolidated financial statements of the Company
for the fiscal year then ended, included in the Company's annual report on Form
10-K.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported financial
statement amounts and related disclosures at the date of the financial
statements. Actual results could differ from these estimates.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets subsequent to their acquisition and provides that intangible
assets with finite useful lives be amortized. The statement also provides that
goodwill and other intangible assets with indefinite lives not be amortized, but
tested at least annually for impairment. The Company will adopt SFAS No. 142 for
its fiscal year beginning January 1, 2002. Upon adoption of SFAS No. 142, the
Company will discontinue the amortization of goodwill with an expected net
carrying value of approximately $10,346,000 at the date of adoption and annual
amortization of $361,000 that resulted from business combinations completed
prior to the adoption.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standard (SFAS) No. 143, Accounting for Asset Retirement Obligations.
SFAS No. 143 requires that an obligation associated with the retirement of
tangible long-lived assets and the associated asset retirement costs be
recognized as a liability when incurred. Upon initial recognition of a liability
for an asset retirement obligation, an entity would capitalize that cost by
recognizing an increase in the carrying amount of the related long-lived asset
by the same amount as the liability. An entity would subsequently allocate that
asset retirement cost to expense using a systematic and rational method over its
useful life. The Company will adopt SFAS No. 143 for its calendar year beginning
January 1, 2003. The adoption of SFAS No. 143 should not have a material effect
on the Company's operating results or financial position.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standard (SFAS) No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. SFAS No. 144 requires that a long-lived asset be considered
held and used until it is disposed of. For the long-lived assets to be disposed
of by sale, the accounting model retains the requirement of Statement 121 to
measure a long-lived asset classified as held for sale at the lower of its
carrying amount or fair value less cost to sell and to cease depreciation.
Therefore, discontinued operations are no longer measured on a net realizable
value basis, and future operating losses are no longer recognized before they
occur. The Company will adopt SFAS No. 144 for its calendar year beginning
January 1, 2002. The adoption of SFAS No. 144 should not have a material effect
on the Company's operating results or financial position.
6
THE CHALONE WINE GROUP, LTD.
NOTE 3 - COMPREHENSIVE INCOME (LOSS)
Comprehensive income includes unrealized foreign currency gains and losses
related to the Company's investment in Chateau Duhart-Milon and gains or losses
relating to derivative instruments. The following is a reconciliation of net
income and comprehensive income (loss) (IN THOUSANDS):
Six months ended
September 30,
--------------------
2001 2000
--------- ----------
Net income $ 940 $ 788
Cumulative effect of adopting SFAS No. 133 (188) -
Changes in fair value of derivatives (374) -
Transition adjustment reclassified in earnings 15 -
Foreign currency translation gain (loss) 288 (803)
--------- ----------
Comprehensive income (loss) $ 681 $ (15)
========= ==========
NOTE 4 - EARNINGS PER SHARE ("EPS")
Basic EPS represents net income divided by the weighted average number of
common shares outstanding for the period. Diluted EPS represents net income
divided by the weighted average number of common shares outstanding while also
giving effect to the potential dilution that could occur if securities or other
contracts to issue common stock (e.g. stock options) were exercised and
converted into stock. This effect is calculated using the treasury stock method.
NOTE 5 - DERIVATIVE INSTRUMENTS
Effective April 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS 133 as amended by SFAS 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities", requires that
derivative instruments, including certain derivative instruments embedded in
other contracts, be recorded as assets or liabilities, measured at fair value.
For each period, changes in fair value are reported in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. SFAS No. 133
also requires the Company to formally document, designate, and assess the
effectiveness of transactions that receive hedge accounting treatment. Upon
adoption of SFAS No. 133, the Company recorded a derivative liability of
$319,000 and, as other comprehensive income, $188,000 ($319,000 pre-tax)
representing the cumulative effect of this change in accounting principle. The
fair value of this derivative (an interest rate swap) as of September 30, 2001
was $953,000. The change in the swap's carrying value from April 1, 2001 to
September 30, 2001 is reflected as a reduction to other comprehensive loss in
shareholders' equity.
The Company uses derivative instruments to manage exposures to interest
rate risks in accordance with its risk management policy. The Company's
objectives for holding derivatives are to minimize the risks using the most
effective methods to eliminate or reduce the exposure to interest rate
fluctuations. The Company formally documents the relationship between hedging
instruments and hedged items as well as its risk management objective and
strategy for undertaking its hedging activities. The Company formally designates
derivatives as hedging instruments on the date the derivative contract is
entered into. The Company assesses, both at inception of the hedge and on an
ongoing basis, whether derivatives used as hedging instruments are highly
effective in offsetting the changes in the fair value or cash flows of hedged
items. If it is determined that a derivative is not highly effective as a hedge
or ceases to be highly effective, the Company discontinues hedge accounting
prospectively.
Changes in the fair value of derivative instruments designated as cash flow
hedges, to the extent the hedges are highly effective, are recorded in other
comprehensive income, net of related tax effects. The ineffective portion of the
cash flow hedge, if any, is recognized in current-period earnings. Other
comprehensive income is relieved when current earnings are affected by the
variability of cash flows relating to the derivative hedged. During the period
ended September 30, 2001, the Company's derivative contracts consisted only of
an interest rate swap used by the Company to convert a portion of its variable
rate long-term debt to fixed rate.
7
THE CHALONE WINE GROUP, LTD.
NOTE 6-SUBSEQUENT EVENTS
On October 9, 2001, Les Domaines Barons de Rothschild (Lafite) ("DBR") and
SFI Intermediate Ltd ("SFI"), our two major shareholders, extended short-term
loans to the Company. The aggregate amount of the loans is up to $8.5 million,
of which $6.8 million has been funded. The loans are unsecured and accrue
interest at a rate of 5.0% per year. Proceeds from the loans are being used for
working capital until the Company receives the proceeds from the rights
offering. The loans are due and payable on the earlier of two business days
after (a) the closing of the rights offering initiated on October 12, 2001 or
(b) the withdrawal and termination of the rights offering prior to its closing.
In connection with these loans, DBR and SFI also agreed that if the rights
offering does not close by November 30, 2001 and we have not withdrawn the
registration statement related to the rights offering, then they shall provide
us with an additional $6.0 million of financing on commercially reasonable terms
that the parties shall negotiate in good faith.
We are conducting a rights offering under which each of our shareholders
has received pro rata rights to purchase additional shares of our common stock.
On September 14, 2001, we filed with the Securities and Exchange Commission a
registration statement on Form S-3 in connection with this rights offering. On
October 10, 2001, we filed an amendment to the registration statement. Proceeds
from the rights offering are expected to retire the short-term loans from DBR &
SFI and for additional working capital. Under this rights offering each
shareholder has been given the right to buy shares of our common stock at $8.50
per share. Shareholders have also been given an oversubscription privilege to
purchase shares for which rights have not been exercised. The Company has
offered rights to purchase up to $15 million of its common stock. As both DBR &
SFI have committed to exercise their respective basic subscription privileges
and oversubscription privileges in full, the Company expects to realize the
entire $15 million of the rights offering.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
From time to time, information provided by the Company, statements made by
its employees, or information included in its filings with the Securities and
Exchange Commission (including this Form 10-Q) may contain statements which are
not historical facts, so called "forward looking statements" that involve risks
and uncertainties. Forward looking statements are made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. When
used in this Form 10-Q, the terms "anticipates," "expects," "estimates,"
"intends," "believes," and other similar terms as they relate to the Company or
its management are intended to identify such forward looking statements. In
particular, statements made in this Item 2, relating to projections or
predictions about the Company's future investments in vineyards and other
capital projects are forward looking statements. The Company's actual future
results may differ significantly from those stated in any forward looking
statements. Factors that may cause such differences include, but are not limited
to (i) reduced consumer spending or a change in consumer preferences, which
could reduce demand for the Company's wines; (ii) competition from numerous
domestic and foreign wine producers which could affect the Company's ability to
sustain volume and revenue growth; (iii) interest rates and other business and
economic conditions which could increase significantly the cost and risks of
borrowings associated with present and projected capital projects; (iv) the
price and availability in the marketplace of grapes meeting the Company's
quality standards and other requirements; (v) the effect of weather,
agricultural pests and disease and other natural forces on growing conditions
and, in turn, the quality and quantity of grapes produced by the Company; (vi)
regulatory changes which might restrict or hinder the sale and/or distribution
of alcoholic beverages and (vii) the risks associated with the assimilation of
acquisitions. Each of these factors, and other risks pertaining to the Company,
the premium wine industry and general business and economic conditions, are more
fully discussed herein and from time to time in other filings with the
Securities and Exchange Commission, including the Company's annual report on
Form 10-K for the year ended March 31, 2001.
DESCRIPTION OF THE BUSINESS
The Company produces, markets and sells super premium, ultra premium, and
luxury-priced white and red varietal table wines, primarily Chardonnay, Pinot
Noir, Cabernet Sauvignon, Merlot, Syrah and Sauvignon Blanc. The Company owns
and operates wineries in various counties of California and Washington State.
The Company's wines are made primarily from grapes grown at the Carmenet Winery,
Edna Valley Vineyard, Chalone Vineyard, Company-owned vineyards adjacent to the
Acacia(TM) Winery, Hewitt Vineyard and Suscol Creek Vineyard in California and
the Canoe Ridge Vineyard in Washington
8
THE CHALONE WINE GROUP, LTD.
State, as well as from purchased grapes. The wines are primarily sold under the
labels "Chalone Vineyard(R)," "Edna Valley Vineyard(R)," "Carmenet(R),"
"Acacia(TM)," "Canoe Ridge Vineyard(R)," "Jade Mountain(R)," "Sagelands
Winery(R)," and "Echelon(TM)".
In France, the Company owns a minority interest in fourth-growth Bordeaux
estate Chateau Duhart-Milon ("Duhart-Milon") in partnership with DBR. The
vineyards of Duhart-Milon are located adjacent to the world-renowned Chateau
Lafite-Rothschild in the town of Pauillac.
RESULTS OF OPERATIONS - SECOND QUARTER AND SIX MONTHS OF FISCAL 2001 COMPARED TO
SECOND QUARTER AND SIX MONTHS OF FISCAL 2000
Three months ended Percent Six months ended Percent
September 30, Change September 30, Change
--------------------------------------------------------------------------------
2001 2000 2001 vs 2000 2001 2000 2001 vs 2000
------------ ------------ --------------- ------------ ---------- ------------
Net revenues 100.0 % 100.0 % 0.0 % 100.0 % 100.0 % 0.0 %
Cost of sales (57.8)% (68.8)% (16.0)% (58.8)% (65.2)% (9.8)%
------------ ------------ ---------- ------------
Gross profit 42.2 % 31.2 % 35.3 % 41.2 % 34.8 % 18.4 %
Other operating revenues, net 0.3 % 0.2 % 50.0 % 0.2 % 0.1 % 100.0 %
Selling, general and admin. expenses (27.8)% (29.6)% (6.1)% (28.0)% (27.8)% 0.7 %
------------ ------------ ---------- ------------
Operating income 14.7 % 1.8 % 716.6 % 13.4 % 7.1 % 88.7 %
Interest expense (7.9)% (7.7)% 2.6 % (7.7)% (7.0)% 10.0 %
Equity in net income of Chateau Duhart-Milon 1.4 % 1.6 % (12.5)% 1.4 % 1.9 % (26.3)%
Other Income 0.0 % 6.1 % (100.0)% 0.0 % 3.0 % (100.0)%
Minority interests (1.4)% 1.1 % (227.3)% (1.2)% (0.4)% 200.0 %
------------ ------------ ------------ -----------
Income before income taxes 6.8 % 2.9 % 134.4 % 5.9 % 4.6 % 28.3 %
Income taxes (2.8)% (1.2)% 133.3 % (2.4)% (2.0)% 20.0 %
------------ ------------ ---------- ------------
Net income 4.0 % 1.7 % 135.3 % 3.5 % 2.6 % 34.6 %
============ ============ ========== ============
NET REVENUES
Net revenues for the three months and six months ended September 30, 2001
decreased approximately 6% and 5%, respectively over the comparable periods in
the prior year. This decrease was caused by lower average revenue-per-case
caused by changes in product mix and lower sales volume primarily due to product
availability.
GROSS PROFIT
Gross profit margin for the three months and six months ended September 30,
2001, increased by approximately 28% and 13%, respectively over the comparable
periods in the prior year. This percentage increase primarily resulted from
lower costs attributable to the release and sale of 2000 vintage wines.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the three months and six
months ended September 30, 2001, decreased approximately $518,000 or 13%, and
$348,000 or 4%, respectively, over the comparable periods in the prior year.
This change was primarily a result of lower selling costs and a postponement of
other promotional activities as compared with the timing of similar efforts in
the prior year.
OPERATING INCOME
Operating income for the three months and six month ended September 30,
2001, increased $1.7 million or 677%, and $1.6 million or 78%, respectively,
primarily due to the lower costs attributable to the release of 2000 vintage
wines and lower selling, general and administrative expenses.
9
THE CHALONE WINE GROUP, LTD.
INTEREST EXPENSE
Interest expense decreased $27,000 for the three months ended September 30,
2001, primarily due to lower interest rates, and increased $112,000 for the six
months then ended due to higher average outstanding borrowings which are a
result of business and property acquisitions during fiscal year 2001 and
continuing capital expenditures related to winery-expansion.
EQUITY IN NET INCOME OF DUHART-MILON
The Company's 23.5% equity interest in the net income of Duhart-Milon for
the three months and six months ended September 30, 2001 are $183,000 and
$382,000 respectively. This change was primarily a result of delayed product
releases as compared to the prior year.
The Company monitors its investment in Duhart-Milon primarily through its
on-going communication with DBR. Such communication is facilitated by the
presence of the Company's chairman on DBR's Board of Directors, and DBR's
representation on the Company's Board of Directors. Additionally, various key
employees of the Company make periodic visits to Duhart-Milon's offices and
production facilities.
Since the investment in Duhart-Milon is a long-term investment denominated
in a foreign currency, the Company records the gain or loss for currency
translation in other comprehensive income or loss, which is part of
shareholders' equity.
MINORITY INTEREST
The financial statements of Edna Valley Vineyard ("EVV") are consolidated
with the Company's financial statements. The interest in EVV attributable to
parties other than the Company is accounted for as a "minority interest". The
minority interest in the net income of EVV for the three months and six months
ended September 30, 2001 was $187,000 and $296,000 respectively. The increase in
minority interest was $341,000, or 221%, and $194,000, or 190%, for each of the
three and six month periods ended September 30, 2001, respectively, when
compared to the same periods last year. These increases were due to the
elimination of the Canoe Ridge minority interest when the Company purchased the
remaining 49.5% interest in Canoe Ridge on February 7, 2001.
NET INCOME
Net income for the three months and six months ended September 30, 2001,
was $525,000 and $940,000 respectively, reflecting an increase of 119% and 19%
over the comparable periods in the prior year. This increase was primarily due
to the lower cost of sales attributable to the release of 2000 vintage wines and
lower selling, general and administrative expenses.
LIQUIDITY AND CAPITAL RESOURCES
Working capital decreased approximately $5.5 million during the six months
ended September 30, 2001 primarily as a result of a decrease in accounts
receivable and increased payables and revolving bank debt to fund property,
plant and equipment expenditures and other cash requirements.
The net increase in the revolving bank loan borrowings from $19.9 million
at March 31, 2001 to $23.4 million at September 30, 2001, reflect the funding of
capital expenditures and other cash requirements. At September 30, 2001, there
were additional borrowings of approximately $1.6 million available under the
revolving bank loan.
The Company has historically financed its growth through increases in
borrowings and cash flow from operations. Management expects that the Company's
working capital needs will grow significantly to support expected future growth
in sales volume. Due to the lengthy aging and processing cycles involved in
premium wine production, expenditures for inventory and fixed assets need to be
made one to three years or more in advance of anticipated sales.
The Company expects to finance these future capital needs through
operations, security offerings and additional borrowings. There can be no
assurance that the Company will be able to obtain this financing on terms
acceptable to the Company.
10
THE CHALONE WINE GROUP, LTD.
DISCLOSURES ABOUT RISK
You should read the following disclosures in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations. These
disclosures are intended to discuss certain material risks of the Company's
business as they appear to management at this time. However, this list is not
exhaustive. Other risks may, and likely will, arise from time to time.
OUR REVENUES AND OPERATING RESULTS FLUCTUATE SIGNIFICANTLY FROM QUARTER TO
QUARTER
We believe period-to-period comparisons of our operating results are not
necessarily meaningful, and cannot be relied upon as indicators of future
performance. In addition, there can be no assurance that our revenues will grow
or be sustained in future periods or that we will maintain our current
profitability in the future. Significant factors in these quarterly
fluctuations, none of which are within our control, are changes in consumer
demand for our wines, the affect of weather and other natural forces on growing
conditions and, in turn, the quality and quantity of grapes produced by us,
interest rates, inventory levels and the timing of releases for certain wines,
among other factors. Consequently, we have experienced, and expect to continue
to experience, seasonal fluctuations in revenues and operating results.
A large portion of our expenses are fixed and difficult to reduce in a
short period of time. In quarters when revenues do not meet our expectations,
our level of fixed expenses tends to exacerbate the adverse effect on net
income. In quarters when our operating results are below the expectations of
public market analysts or investors, the price of our common stock may be
adversely affected.
REDUCED CONSUMER SPENDING COULD LESSEN DEMAND FOR OUR WINES AND HARM OUR
BUSINESS
Consumer spending trends and changes in consumer tastes have a substantial
impact on the wine industry and our business. To the extent that wine purchases
are negatively impacted by economic and other factors, or wine consumers reduce
consumption of wine in favor of other beverages, demand for our wines could
decrease.
OUR BUSINESS IS SEASONAL, WHICH COULD CAUSE OUR MARKET PRICE TO FLUCTUATE
Our business is subject to seasonal as well as quarterly fluctuations in
revenues and operating results. Our sales volume tends to increase during the
summer months and the holiday season and decrease after the holiday season. As a
result, our sales and earnings are typically highest during the fourth calendar
quarter and lowest in the first calendar quarter. Seasonal factors also affect
our level of borrowing. For example, our borrowing levels typically are highest
during winter when we have to pay growers for grapes harvested and make payments
related to the grape harvest. These and other factors may cause fluctuations in
the market price of our common stock.
OUR PROFITS DEPEND LARGELY ON SALES IN CERTAIN STATES AND ON SALES OF
CERTAIN VARIETALS
In the six months ended September 30, 2001, approximately 89% of our wine
sales were concentrated in 20 states. Changes in national consumer spending or
consumer spending in these states and other regions of the country could affect
both the quantity and price level of wines that customers are willing to
purchase which could harm our business.
Approximately 87% of our consolidated net revenues in the six months ended
September 30, 2001 were concentrated in our four top selling varietal wines.
Specifically, sales of Chardonnay, Cabernet Sauvignon, Pinot Noir, and Merlot
accounted for 47%, 15%, 13% and 12% of our net revenues, respectively. Changes
in consumer preferences with respect to these varietal wines could adversely
affect our business.
COMPETITION MAY HARM OUR BUSINESS
The premium table wine industry is intensely competitive and highly
fragmented. Our wines compete in all of the premium wine market segments with
many other premium domestic and foreign wines, with imported wines coming
primarily from the Burgundy and Bordeaux regions of France and, to a lesser
extent, Italy, Chile, Argentina, South Africa and Australia. Our wines also
compete with popular-priced generic wines and with other alcoholic and, to a
lesser degree, non-alcoholic beverages, for shelf space in retail stores and for
marketing focus by our independent distributors, many of which carry extensive
brand portfolios.
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THE CHALONE WINE GROUP, LTD.
The wine industry has experienced significant consolidation. Many of our
competitors have greater financial, technical, marketing and public relations
resources than we do. Our sales may be harmed to the extent we are not able to
compete successfully against such wine or alternative beverage producers.
OUR BUSINESS IS SUBJECT TO A VARIETY OF AGRICULTURAL RISKS
Winemaking and grape growing are subject to a variety of agricultural
risks. Various diseases, pests, fungi, viruses, drought, frosts and certain
other weather conditions can affect the quality and quantity of grapes available
to us, decreasing the supply of our products and negatively impacting
profitability.
Many California vineyards have been infested in recent years with
phylloxera. Our vineyard properties are primarily planted to rootstocks believed
to be resistant to phylloxera. However, there can be no assurance that our
existing vineyards, or the rootstocks we are now using in our planting programs,
will not become susceptible to current or new strains of phylloxera.
Pierce's Disease is a vine bacterial disease that has been in California
for more than 100 years. It kills grapevines and there is no known cure. Small
insects called sharpshooters spread this disease. A new strain of the
sharpshooter, the glassy winged, was discovered in Southern California and is
believed to be migrating north. We are actively supporting the efforts of the
agricultural industry to control this pest and are making every reasonable
effort to prevent an infestation in our own vineyards. We cannot, however,
guarantee that we will succeed in preventing contamination in our vineyards.
Grape growing requires adequate water supplies. We generally supply our
vineyards' water needs through wells and reservoirs located on our properties.
We believe that we either have, or are currently planning to insure, adequate
water supplies to meet the needs of all of our vineyards. However, a substantial
reduction in water supplies could result in material losses of grape crops and
vines.
The weather phenomenon commonly referred to as "El Nino" produced heavy
rains and cooler weather during the spring of 1999 and 1998, which resulted in
colder and wetter soils than are typical during California's grape growing
season. Consequently, the 1999 and 1998 harvests were postponed by approximately
four to six weeks depending on the geographic location and varietals. The
unusual weather conditions resulting from El Nino impacted the quantity and
quality of our 1998 estate harvest. The size of our most significant crops
ranged from normal-sized yields to 50% of normal yields (depending on the
varietal and particular estate).
Despite the reduction in the yield, harvested estate crops, in combination
with contracted grape purchases, are expected to permit us to meet originally
anticipated sales projections from our 1999 and 1998 vintage Chardonnay,
Cabernet, and Merlot varietals. Together, these varietals have historically
comprised between 80% and 85% of our aggregate annual production.
WE MAY NOT BE ABLE TO GROW OR ACQUIRE ENOUGH QUALITY GRAPES FOR OUR WINES
The adequacy of our grape supply is influenced by consumer demand for wine
in relation to industry-wide production levels. While we believe that we can
secure sufficient supplies of grapes from a combination of our own production
and from grape supply contracts with independent growers, we cannot be certain
that grape supply shortages will not occur. A shortage in the supply of wine
grapes could result in an increase in the price of some or all grape varieties
and a corresponding increase in our wine production costs.
AN OVERSUPPLY OF GRAPES MAY ALSO HARM OUR BUSINESS
Current trends in the domestic and foreign wine industry point to rapid
plantings of new vineyards and replanting of old vineyards to greater densities,
with the expected result of significantly increasing the worldwide supply of
premium wine grapes and the amount of wine which will be produced in the future.
This expected increase in grape production could result in an excess of supply
over demand and force us to reduce, or not increase, our prices.
WE DEPEND ON THIRD PARTIES TO SELL OUR WINE
We sell our products primarily through independent distributors and brokers
for resale to retail outlets, restaurants, hotels and private clubs across the
United States and in some overseas markets. To a lesser degree, we rely on
direct sales from our
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THE CHALONE WINE GROUP, LTD.
wineries, our wine library and direct mail. Sales to our largest distributor and
to our nineteen largest distributors combined represented approximately 5% and
44%, respectively, of our net revenues during the six months ended September 30,
2001. Sales to our nineteen largest distributors are expected to continue to
represent a substantial portion of our net revenues in the future. We use a
single broker to sell our wines within California. Such sales represent 42% of
our net revenues during the six months ended September 30, 2001. The laws and
regulations of several states prohibit changes of distributors, except under
certain limited circumstances, making it difficult to terminate a distributor
for poor performance without reasonable cause, as defined by applicable
statutes. Any difficulty or inability to replace distributors, poor performance
of our major distributors or our inability to collect accounts receivable from
our major distributors could harm our business.
NEW REGULATIONS OR INCREASED REGULATORY COSTS COULD HARM OUR BUSINESS
The wine industry is subject to extensive regulation by the Federal Bureau
of Alcohol, Tobacco and Firearms and various foreign agencies, state liquor
authorities and local authorities. These regulations and laws dictate such
matters as licensing requirements, trade and pricing practices, permitted
distribution channels, permitted and required labeling, advertising and
relations with wholesalers and retailers. Any expansion of our existing
facilities or development of new vineyards or wineries may be limited by present
and future zoning ordinances, environmental restrictions and other legal
requirements. In addition, new regulations or requirements or increases in
excise taxes, income taxes, property and sales taxes or international tariffs,
could reduce our profits. Future legal or regulatory challenges to the industry,
either individually or in the aggregate, could harm our business.
WE WILL NEED MORE WORKING CAPITAL TO GROW
The premium wine industry is a capital-intensive business, which requires
substantial capital expenditures to develop and acquire vineyards and to improve
or expand wine production. Further, the farming of vineyards and acquisition of
grapes and bulk wine require substantial amounts of working capital. We project
the need for significant capital spending and increased working capital
requirements over the next several years, which must be financed by cash from
operations and, by additional borrowings or additional equity.
ADVERSE PUBLIC OPINION ABOUT ALCOHOL MAY HARM OUR BUSINESS
A number of research studies suggest that various health benefits may
result from the moderate consumption of alcohol, but other studies suggest that
alcohol consumption does not have any health benefits and may in fact increase
the risk of stroke, cancer and other illnesses. If an unfavorable report on
alcohol consumption gains general support, it could harm the wine industry and
our business.
WE USE PESTICIDES AND OTHER HAZARDOUS SUBSTANCES IN THE OPERATION OF OUR
BUSINESS
We use pesticides and other hazardous substances in the operation of our
business. If hazardous substances are discovered on, or emanate from, any of our
properties, and their release presents a threat of harm to public health or the
environment, we may be held strictly liable for the cost of remediation. Payment
of such costs could have a material adverse effect on our business, financial
condition and results of operations. We maintain insurance against these kinds
of risks, and others, under various insurance policies. However, our insurance
may not be adequate or may not continue to be available at a price or on terms
that are satisfactory to us.
CONTAMINATION OF OUR WINES WOULD HARM OUR BUSINESS
We are subject to certain hazards and product liability risks, such as
potential contamination, through tampering or otherwise, of ingredients or
products. Contamination of any of our wines could result in the need for a
product recall which could significantly damage our reputation for product
quality, which we believe is one of our principal competitive advantages. We
maintain insurance against these kinds of risks, and others, under various
general liability and product liability insurance policies. However, our
insurance may not be adequate or may not continue to be available at a price or
on terms that are satisfactory to us.
THE LOSS OF KEY EMPLOYEES WOULD DAMAGE OUR REPUTATION AND BUSINESS
Our success depends to some degree upon the continued services of a number
of key employees. Although some key employees are under employment contracts
with us for specific terms, the loss of the services of one or more of our key
employees could harm our business and our reputation, particularly if one or
more of our key employees resigns to join a competitor or to form a competing
company. In such an event, despite provisions in our employment contracts, which
are designed to prevent the unauthorized disclosure or use of our trade secrets,
practices or procedures by such personnel under these circumstances, we cannot
be certain that we would be able to enforce these provisions or prevent such
disclosures.
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THE CHALONE WINE GROUP, LTD.
SHIFTS IN FOREIGN EXCHANGE RATES OR THE IMPOSITION OF ADVERSE TRADE
REGULATIONS COULD HARM OUR BUSINESS
We conduct some of our import and export activity for wine and packaging
supplies in foreign currencies. We purchase foreign currency on the spot market
on an as-needed basis and engage in limited financial hedging activities to
offset the risk of exchange rate fluctuations. There is a risk that a shift in
certain foreign exchange rates or the imposition of unforeseen and adverse trade
regulations could adversely impact the costs of these items and have an adverse
impact on our operating results.
In addition, the imposition of unforeseen and adverse trade regulations
could have an adverse effect on our imported wine operations. Export sales
accounted for approximately 4% of total consolidated revenue for the six months
ended Septmber 30, 2001. We expect the volume of international transactions to
increase, which may increase our exposure to future exchange rate fluctuations.
INFRINGEMENT OF OUR TRADEMARKS MAY DAMAGE OUR BRAND NAMES OR OUR BUSINESS
Our wines are branded consumer products, and we distinguish our wines from
our competitors' by enforcement of our trademarks. There can be no assurance
that competitors will refrain from infringing our marks or using trademarks,
tradenames or trade dress which dilute our intellectual property rights, and any
such actions may require us to become involved in litigation to protect these
rights. Litigation of this nature can be very expensive and tends to divert
management's time and attention.
OUR ACQUISITIONS AND POTENTIAL FUTURE ACQUISITIONS INVOLVE A NUMBER OF
RISKS
Our acquisition of Staton Hills Winery (renamed Sagelands Winery), the
possible construction of a new winery on the Suscol Ranch property we recently
acquired and potential future acquisitions involve risks associated with
assimilating these operations into our company; integrating, retaining and
motivating key personnel; integrating and managing geographically-dispersed
operations because Staton Hills is in Washington State and we are headquartered
in California; integrating the technology and infrastructures of disparate
entities; producing wine in, and marketing wine from, Washington State; and
replanting existing vineyards from white wine grapes to red wine grapes.
We relied on debt financing to purchase Hewitt Ranch, Suscol Ranch, Staton
Hills Winery, the Jade Mountain brand and other vineyard land and related assets
during the fiscal year ended March 31, 2001. Consequently our debt-to-equity
ratio is high in relation to our historical standards. The interest costs
associated with this debt will increase our operating expenses and the risk of
negative cash flow.
THE MARKET PRICE OF OUR COMMON STOCK FLUCTUATES
All of the foregoing risks, among others not known or mentioned in this
report, may have a significant effect on the market price of our shares. The
stock markets have experienced extreme price and volume trading volatility in
recent months and years. This volatility has had a substantial effect on the
market prices of securities of many companies for reasons frequently unrelated
or disproportionate to the specific company's operating performance and could
similarly affect our market price.
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THE CHALONE WINE GROUP, LTD.
PART II. - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
None.
(b) Reports on Form 8-K.
The Company filed a report on Form 8-K (Item 5), dated October 19,
2001, to report the Company's announcement of a new price, record date
and expiration date for the Company's rights offering.
The Company filed a report on Form 8-K (Item 5), dated September 28,
2001, to report the Company's announcement of its plans for a rights
offering to its shareholders.
The Company filed a report on Form 8-K (Item 5), dated September 21,
2001, to report that the Company's two largest shareholders had entered
into a voting agreement.
The Company filed a report on Form 8-K (Item 5), dated August 31, 2001,
to report the Company's announcement of W. Philip Woodward's
resignation as chairman of the board.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 14, 2001 THE CHALONE WINE GROUP, LTD.
- -------------------------- ----------------------------
(Registrant)
/s/ THOMAS B. SELFRIDGE
--------------------------------------------
Thomas B. Selfridge
President and Chief Executive Officer
Dated: November 14, 2001 /s/ SHAWN CONROY BLOM
- ------------------------- --------------------------------------------
Shawn Conroy Blom
Vice President and Chief Financial Officer
15